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Forbearance and Prompt Corrective Action

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  • Narayana R Kocherlakota
  • Ilhyock Shim

Abstract

This paper investigates whether a bank regulator should terminate problem banks promptly or exercise forbearance. We construct a dynamic model economy in which entrepreneurs pledge collateral, borrow from banks, and invest in long-term projects. We assume that collateral value has aggregate risk over time, that in any period entrepreneurs can abscond with the projects but losing the collateral, and that depositors can withdraw deposits. We show that optimal regulation exhibits forbearance if the ex-ante probability of collapse in collateral value is sufficiently low, but exhibits prompt termination of problem banks if this probability is sufficiently high.

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Bibliographic Info

Paper provided by UCLA Department of Economics in its series Levine's Bibliography with number 784828000000000512.

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Date of creation: 26 Oct 2005
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Handle: RePEc:cla:levrem:784828000000000512

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  1. Bengt Holmstrom & Jean Tirole, 1996. "Private and Public Supply of Liquidity," NBER Working Papers 5817, National Bureau of Economic Research, Inc.
  2. Dekle, Robert & Kletzer, Kenneth, 2003. "The Japanese Banking Crisis and Economic Growth: Theoretical and Empirical Implications of Deposit Guarantees and Weak Financial Regulation," Santa Cruz Department of Economics, Working Paper Series qt0t6321ds, Department of Economics, UC Santa Cruz.
  3. Christopher Sleet & Bruce D. Smith, 2000. "Deposit insurance and lender-of-last-resort functions," Proceedings, Federal Reserve Bank of Cleveland, pages 518-579.
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Cited by:
  1. Ilhyock Shim & Goetz von Peter, 2007. "Distress selling and asset market feedback," BIS Working Papers 229, Bank for International Settlements.
  2. Ilhyock Shim, 2006. "Dynamic prudential regulation: Is prompt corrective action optimal?," BIS Working Papers 206, Bank for International Settlements.
  3. Eijffinger, Sylvester C W & Nijskens, Rob, 2011. "Complementing Bagehot: Illiquidity and insolvency resolution," CEPR Discussion Papers 8603, C.E.P.R. Discussion Papers.
  4. Cristina Arellano & Narayana Kocherlakota, 2008. "Internal Debt Crises and Sovereign Defaults," Levine's Bibliography 122247000000001880, UCLA Department of Economics.
  5. Xavier Freixas & Bruno Maria Parigi, 2007. "Banking Regulation and Prompt Corrective Action," CESifo Working Paper Series 2136, CESifo Group Munich.
  6. Robert E. Hall, 2008. "Equity Depletion from Government-Guaranteed Debt," NBER Working Papers 14581, National Bureau of Economic Research, Inc.

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